Reversing charges

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By Cees Bruggemans

The biggest daily risk facing South Africa is a sudden stop and then reversal of capital inflows, sinking the Rand, boosting inflation and interest rates.

Such an outcome could see a massive asset sell-off. There would also be a major change in the composition of growth (favouring some producers at the expense of indebted households and those producers servicing them).

This nightmare is actually happening to other countries right now and is risked by yet others, while we keep sailing on serenely. What’s up, Doc?

Lesson number one. Don’t be stupid.

Like Russia, for instance. Had everything going for it. Unbelievable natural resources such as oil and gas. Export prices went through to the roof, with the windfall further doubled up by huge capital inflows.

Ten years ago, exactly to the day, they defaulted on some external debt, causing much global grief, including the demise of LTCM, and what that did to the world.

Ten years later, they sit on $500bn in foreign reserves, own a major sovereign wealth fund, and count more Dollar billionaires than you have toes and fingers.

And what do they do? They mess up. Lash out at small aggressive neighbours. Upset the global partners. Deeply unsettle foreign investors.

And in a matter of weeks, their stock exchange valuation halved. Foreign investors withdraw. An enormous forex drain got underway.

That’s the kind of stuff of our nightmares. But it isn’t playing locally. It is Russia that messed up, in typical KGB-style, and it is starting to count the cost, though they on Friday also bounced 30% as the world roared approval of US financial actions.

Our politics should perhaps take note and reconsider some of the wilder schemes currently being bandied about as if there are no constraints to reckon with.

Happily, so far neither the world nor our comrades have done their worst. There’s time to think things through.

Lesson number two. Don’t be stupid.

The country in question this time is the only superpower left standing, but increasingly looking like a huge undisciplined emerging country on the make, and possibly about to blow all its advantages, and reap the whirlwind.

And the process? Detonate your financial system, thereafter cleaning up by hugely increasing public burdens. Give foreigners something to worry about.

The world may wake up some day, and decide it doesn’t like the risk profile. And proceed to sink the Dollar, boosting US inflation, and walk away from supposedly safe-haven Treasury bonds, boosting US interest rates, and devastating its growth.

Can’t happen? Kenneth Rogoff, ex-IMF chief economist sees this as a major US risk scenario.

The most unbelievable financial irresponsibility was allowed to mushroom into incredible financial leveraging, which is now being brutally imploded, taking out respected financial names three at a time.

So far, the write-offs this past year amount to $500bn. But there is another $1tn looming that will need to be settled fairly shortly.

Even if miracles do happen, and they do, and private bank provisioning, predatory bank take-outs and ultimately the government bailout of a lifetime cleans up the US financial system, its sovereign reputation will have been burnished, its good name no longer what it used to be, the penalties lingering for years, in an impaired fiscal burden and underperforming growth story trying to pay off this generational folly.

In there somewhere, Rogoff claims, is a currency penalty as foreigners refuse to accord the US unchanged financial status with such an impaired reputation.

Here we are, worried about a faceless ambush on our fragile balance of payments and exposed currency, if for the only reason that we experienced such ambushes before, most memorial in 1985, 1998 and 2001.

Yet it may be mostly bad conscience that makes us fear a repeat of sudden stops and foreign capital reversals, sinking everything in sight at great cost to us, even if such risks aren’t negligible in a turbulent world.

It is in fact America, for the past six decades carried by its superpower status, which has had the ultimate financial free ride ever that faces Armageddon.

For why would the world keep on rewarding such unbelievable foolishness indefinitely?

Over the past week, global panic favoured the usual safe havens, with gold enjoying its biggest daily jump (back to nearly $900 before correcting), and the three-month US Treasury bill (its yield collapsing to 0.15%, the lowest since 1941).

So far, the world keeps carrying the US, as yet not having lost its appetite for US assets. But the US risk profile is steadily changing, now greatly accelerated by the financial crisis of recent times.

If anybody currently faces the risk of sudden stops and reversals, it is probably the US.

And a dramatic downward adjustment in the Dollar would probably boost commodity prices, especially gold.

All of that also holds Rand risks. Probably mostly firming ones. The one outcome few apparently want to think about.

Source: Cees Bruggemans, FNB, September 22, 2008.


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